(Note: This article was published in the newsletter on July 1, 2022, and has been updated as needed.)
Earthstone Energy (New York Stock Exchange:ESTE) It was Announced the acquisition of Titus. This comes after several important acquisitions that the company has expanded to Several times before the shopping spree begins. The share price is starting to reflect concerns about several acquisitions as well as dealing with more outstanding shares. Investors need to keep in mind that sellers who receive a stock often sell that stock. This will lower the stock price until the big seller exits.
The market also has concerns about management making so many significant acquisitions in such a small space of time. This management may prove that these fears are unfounded because management has built and sold companies before. However, it is clear that the market is taking more risk in the stock price.
The current debt measures described above are clearly conservative. The concern is that the debt is growing at a very fast rate and that the company is expanding rapidly. Therefore, the reported overdue debt ratio will not reflect the above figures until a full year of operations is reported with all acquisitions.
This market sees ghosts everywhere. There is no worse nightmare for the market than a high debt ratio. Despite having production on the most recent leases purchased (and thus steady cash flow), management still has to report essentially mixed numbers in order for the company to operate for one year.
The market is concerned when there is one major acquisition around risks such as the logistics of combining major acquisitions into a perfect mix. Here, there are now several big acquisitions. So these fears began to multiply.
Clearly, the market’s reaction to the latest acquisition announcement has been less than stellar. Some of this is due to the recent drop in oil prices and other market concerns about the industry.
Another concern is that the chain of transactions creates large shareholders from the shares issued through these transactions. One of these, Warburg Pincus Just announced the acquisition of a large amount of shares. A large shareholder can reduce the stock price significantly until sales pressure decreases. This company issued a lot of shares to acquire a good number of real estate. There is an additional risk that some large sellers will liquidate their holdings to delay the stock’s appreciation when the combined results indicate a stock price appreciation.
But the acceleration of debt growth has also worried the market. Your first business will likely be to pay off that debt as quickly as possible. Admittedly, management may use some of the cash flow initially to combine acquisitions with operations improvement. But if the cash flow is as generous as the administrative states, then debt repayment should begin fairly quickly.
This is an industry known for its poor vision and often has unpleasant surprises. Although the current recovery appears to be sustainable for a while, long-term readers know we went this route before we quickly became disappointed. Therefore, it may be time to slow down the shopping spree to allow the market to see the benefits of “new” Earthstone Energy.
Perhaps the concern is not the debt ratio in the current pricing environment, but the debt ratio when commodity prices are much lower. Having gone through some tough situations in both 2008 and 2020 (and less severe ones like 2015), this market has an increasingly anxious view of debt.
On top of that, the market was disappointed by the “one decision” stock that was no longer as “safe” as the market had thought. This generally results in a swing towards safety as Mr. Market goes out to sea as usual. This means that managerial expertise may not be valued as in other market climates (or situations).
It is clear that management is addressing these concerns by explaining the evaluation method they are using. It helps that many of these acquisitions arrive with established infrastructure and transportation commitments. The company will most likely retain the necessary employees as well as this reduces the risk of new employees who are not familiar with the rental operations.
The real key to the market will be the company’s performance during the next downturn. All of these acquisitions made it a materially new company with no public operating date. Therefore, investors should expect some stock pricing action similar to other new issues (rather than an existing company) until there is sufficient evidence of outperformance.
one of the keys To improve market performance it will be to maintain the low costs described above along with at least expected well performance data. If management is able to keep pace with the technological changes sweeping the industry to maintain the cost leadership described above, it is likely to result in superior pricing action.
It is clear that management has acquired some excellent spaces. May be concerns about the logistics involved in rapid growth. Inexperienced management can easily lose control of costs or quality (which would quickly cost customers in the commodity business). This is also part of the concern about debt service.
Share price performance is likely to underperform the rest of the industry until it is clear that management can report satisfactory (or better) results than the combined company. This latest acquisition should add economies of scale in one of the most profitable areas of Permian.
Oftentimes, it is difficult for individual investors to be sure of synergies. But what will catch the market’s attention are wide margins, low costs and, of course, above average profitability.
Management minimized the risk of all acquisitions by purchasing fixed production. Management further reduced the risk by keeping the rig count constant while allowing an additional rig once all new acquisitions are understood.
The debt ratio remains low in the current environment. But the market is likely to want evidence of a lower debt ratio when commodity prices are significantly lower. Steady production from procurement gives management a big head start on this requirement.
Despite market concerns, the best assets besides the shareholders are this management and their experience (along with the success described above). Obviously, this stock is not for everyone. But good management can surprise the upside. This seems to be very good management.